ContextSpeech by the Governor of the Bank of Italy at a meeting of a central bank research network he helped launch in 2024.
Why it mattersA thoughtful Bank of Italy speech on how monetary policy must change when geopolitical shocks become permanent rather than temporary.
- Geopolitical tensions and trade fragmentation are now lasting features.
- Uncertainty is both high and persistent.
- New shocks are hard to classify as supply or demand shocks.
- Periodically review how the inflation outlook is assessed.
- Reassess the policy stance and how the central bank reacts.
- Use research networks to understand structural change.
Read the speech summary
1. A changing world for central banks
Closing a European central bank research network on monetary policy transmission in Rome, the Governor of the Bank of Italy noted that the shocks he called exceptional in 2024 have become permanent features. Geopolitical tension, trade fragmentation and technological disruption hit both supply and demand and can alter how monetary policy itself works. This calls for regular review of how central banks read inflation, judge their stance and decide, while keeping price stability as the mandate. The review of its strategy completed by the ECB in 2025 already moved in that direction. He structured his remarks around three questions: how to handle an energy shock that lifts inflation while weakening activity, how structural shifts alter the outlook and the channels of policy, and how decisions should be taken when uncertainty is this high.
2. The euro area before and after the Gulf war
In 2025 the euro area absorbed US tariffs, Chinese competition and high uncertainty, growing 1.4% (about 1% without Ireland) thanks to employment, defence and transition investment and easier policy, while inflation returned to target. Two warning signs remained: households kept saving more than before the pandemic, and industry stalled under Chinese competition in high-tech sectors, hitting manufacturing countries such as Germany and Italy and possibly reducing future growth potential if it discourages investment. The war in the Persian Gulf then raised costs, selling prices and short-term inflation expectations, while consumer confidence and services activity fell and banks tightened lending.
3. Neither ignore nor overreact
He rejected two simple answers. Looking through the shock underestimates it: damage to infrastructure could keep prices high, and the Strait of Hormuz also carries fertilisers and aluminium. Policy cannot stop energy costs from spreading but must prevent them from shaping wage and price expectations. Yet this is not 2022: demand is weaker, real rates are higher, oil rather than gas is driving the shock, and Europe has more LNG capacity and renewable power. Large cost shocks pass quickly into prices, as firms now reprice faster with digital tools and households recently scarred by inflation adjust expectations sooner, but they also cut spending and investment. The ECB raised its deposit rate by a quarter point in June because projections showed inflation at 3% in 2026 returning to target in late 2027, risks were tilted upwards and expectations had to stay anchored; the decision held up across scenarios. Talks between Washington and Tehran could lower energy prices, but no path is predetermined.
4. The Great Reconfiguration
Fragmentation, AI and digital finance, ageing and climate change are transforming the economy at the same time, a period he called a Great Reconfiguration after the Great Moderation. He drew a cautious parallel with the Belle Époque before 1914, when innovation, trade and financial integration coexisted with inequality, rivalry and an arms race, to show that structural change rarely unfolds smoothly.
5. Three questions for policy
First, trends interact: AI needs energy and water and so complements the green transition, which it can also accelerate, while fragmentation may cut access to inputs and data and ageing may limit skills. This makes it harder to tell lasting change from cyclical swings, and humility is needed with real-time data. Second, transmission may change: AI pricing and digital banking could make inflation and deposit rates react faster, whereas older populations borrow less for homes and goods and strategic investment in resilience responds less to borrowing costs. The effect of a rate change thus becomes less predictable and must be reassessed constantly. Third, the reaction function must adapt: demographics push the neutral rate down while AI and fragmentation act in both directions, so central banks should test decisions against alternative scenarios on energy, supply chains, productivity, finance and expectations, not only a central forecast. Structural change may also shift where financial stability risks sit. Mistaking a lasting productivity gain for overheating would make policy too tight, while treating a temporary boom as permanent capacity would make it too loose.
6. Conclusion
Supply shocks are becoming more frequent, persistent and tied to structural change. Central banks must draw on computer science, political and climate science and energy economics, and work across disciplines, keeping their mandate in sight while adapting their analysis. Just as epidemiology entered policy debates during the pandemic, new fields are now part of the toolkit. He thanked the research network for taking these questions seriously from its launch and expected its partnerships between economists and other specialists to keep producing results as the future approaches faster than anticipated.